U.S. Markets Playing 'Follow the Leader'

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Includes: DIA, QQQ, SPY
by: Larry Doyle

Tuesday’s rise in rates by the Australian central bank is a bellweather sign of the global shift in the balance of economic power. While the rise in rates by the Aussies is the first central bank move, it certainly will not be the last.

Why did the Aussies raise rates and what does it mean both in the short term and for the long haul? Let’s navigate.

The Australian economy did not have near the level of debt that burdens the U.S. and Europe and thus they did not need near the amount of monetary stimulus to weather this global recession. Additionally, Australia has benefited from extensive trade in the Asian hemisphere.

The knee jerk reaction in the markets was focused primarily on a selloff in the greenback which supported a move higher in commodities and global equities via the ‘positive carry trade.’ The commodity which garnered the greatest focus was gold, which moved toward $1040/ounce.

What do these moves mean? I see cross currents on the economic landscape, including:

1. The dollar may not necessarily continue to weaken, but given its current weakness it will support those companies which garner a greater degree of sales overseas.

2. A weak dollar is usually affiliated with inflation. I do not think we are in a position to look at prices in terms of one overall index. Why? Given the technical and fundamental factors in our economy, certain price components will likely project increased inflation while others will not.

To be more specific, given the labor situation in our country, I do not see any appreciable increase in wages anytime soon. In fact, I think it is likely wages will trend lower.

Given the glut of supply and vacancies in both the residential and commercial real estate markets, I have a tough time believing these prices will move appreciably higher anytime soon.

Commodities may very well move higher. Why? High five to MC for sharing with me that there is increased dialogue in the international trade community to move oil away from trading in dollars. In fact, that story likely had a big impact in yesterday’s trading. Even if there is not an immediate shift in this market dynamic, the mere fact that it is being discussed will support oil specifically, oil-based products broadly, and other commodities as well.

Given that these commodities are primarily inputs, the prices for the outputs will likely move higher. This development is clearly inflationary.

3. What happens to interest rates here in the United States? While on one hand we have some deflationary forces at work which would keep rates low, we have the tug of other factors pushing them higher. How does it play out? My gut instinct tells me that overall pools of capital will be flowing away from the United States and, as such, people and private corporations will have to pay more to attract capital here in our country. I think those entities which focus the bulk of their economic activity here in the United States will be forced to pay higher rates to attract funding.

4. What about our equity markets and the Fed? While the Fed will want to keep our rates low for an ‘extended period,’ they may not have that luxury. If other nations follow Australia in raising rates, the U.S. may need to withdraw some liquidity sooner rather than later. Kansas City Fed chair Thomas Hoenig made this very assertion Tuesday.

What would higher rates mean or even the thought of higher rates mean? Slower growth and a tough road for equities going forward.

Thoughts, comments, questions always appreciated.